Global Tax Alert: Spanish tax authorities deny withholding tax exemption on the grounds of the general anti-abuse clause

The Spanish tax authorities challenged and denied the applicability of a domestic exemption of interest payments made by a Spanish tax resident entity to a Dutch tax resident entity on the grounds of a general anti-abuse rule arguing that the Dutch entity did not have sufficient substance.

In the case at hand, a Spanish tax resident entity received funds (by means of credit facilities and participating loan agreements) from a Dutch tax resident company acting as lender, both entities being part of a Group whose parent company was tax resident in the United States. The interest payments were considered by the Spanish entity as exempt for withholding tax purposes, given that the Spanish legislation foresees that interest payments made to EU tax residents are exempt from Non-Resident Income Tax.

The Dutch tax authorities spontaneously informed the Spanish tax authorities about the Dutch lender, qualifying as a financial services company, and not being compliant with the minimum substance requirements from a domestic perspective due to the fact that the accounting and bookkeeping files were not kept physically in the country.

Further to the information received from the Dutch tax authorities the Spanish tax authorities conducted a tax audit and determined that the Dutch financial services company was a mere conduit entity with no real substance in the Netherlands, only acting as an intermediary between the payor entity of the interest and the beneficial owner (the ultimate parent company). This conclusion was reached as a result of the consideration of the following facts:

• The key purpose of the Dutch financial services company was to receive funds from the ultimate parent company and finance the Spanish group entity. In this regard, the funds flow of principal and interest were nearly identical between the Spanish and the Dutch entity and between the Dutch and the ultimate parent company, constituting a back-to-back loan.
• The Dutch entity had no human nor material resources, and its corporate address was provided by a trust office under which address other 4.200 financial entities were domiciled.
• The majority of the members of the Board of Directors of the Dutch lender were also members of the Board of the trust office and other finance services entities and the remainder where members of the Board of the parent company.

The European Union Court of Justice has ruled in the Danish Cases that the condition of beneficial owner constitutes a material requirement in order to apply the exemption foreseen by the European legislation. In this case the Spanish tax authorities argue that the beneficial ownership, although not being expressly foreseen in the wording of the Law, is an implicit requirement in order to apply the Spanish exemption.

Moreover, the Spanish tax authorities conclude that a general anti-abuse clause is applicable, given that these transactions, considered in their entirety, where artificial in the sense that the Dutch finance services company was a mere conduit vehicle with no substance and economic activity nor valid economic reasons. The lack of human and material resources precluded the entity of carrying out any kind of activity aside from simple intermediation. In this regard, it is considered that the only rationale behind this structure was to obtain a tax exemption which would not have been available should the ultimate parent company had granted the funds directly. Therefore, it is to be understood that no legal or economic activity supports the financing structure, aside of obtaining a tax saving.

The practical consequence of applying the general anti-abuse clause by the Spanish tax authorities is the adoption of a look-through approach, as a result of which the Spanish tax authorities will apply the tax treatment applicable to the beneficial owner of the interest payments.

This criteria of the Spanish tax authorities is in line with previous interpretations of the Danish Cases by the Spanish tax courts (Central Economic Administrative Court), but opens up the door to further uncertainty for multinational financing structures.

Key takeaways

We recommend multinational groups with financing in Spain through EU intermediary lenders to revisit their structures in order to asses potential alternatives which mitigate the risk of the Spanish tax authorities denying the withholding exemption on interest payments.

The application of a general anti-abuse clause does not only avoid the possibility of exempt interest payments, but it may also result in corresponding penalties and rejection of Mutual Agreement Procedures.